As businesses become increasingly global and the boundaries of investment continue to fade, investors as well as promoters want to own businesses in India.
The notification of the provisions relating to cross-border mergers under the new company law is a welcome step, as it opens up vast possibilities for Indian companies and businesses to buy and sell businesses within the country and overseas. With this, India enters a select group of countries that permit a domestic company to shift its governing law and domicile overseas, by way of a merger process. There are a number of ways to shift the place of residence overseas that are usually recognised in laws that are specific to each country—re-domiciliation, shifting tax residence and merger being some of them. While India still does not permit an Indian company to re-domicile overseas or shift its place of tax residence outside the country, it is now permitted for Indian companies to merge into foreign companies situated in identified jurisdictions.
Likewise, a foreign company is also permitted to merge into an Indian company. This is likely to open up newer avenues in which Indian businesses and business owners reorganise their businesses that have an overseas connect. While the merger of a foreign company into an Indian company was permitted under the earlier law as well, an Indian company being allowed to merge overseas has been liberalised only with the new law.
As businesses become increasingly global and the boundaries of investment continue to fade, we have seen a trend towards investors as well as promoters wanting to own businesses in India through external structures. This is done for a variety of reasons, including investor access, overseas listing potential, tax efficiencies and business requirements. An overseas merger potentially provides another possibility for externalisation of business.
The rules issued by the ministry of corporate affairs provide for only identified jurisdictions with which such inbound or outbound mergers can be implemented. This is to ensure that only jurisdictions that have sufficient protection against banking irregularities, frauds, anti-money laundering, etc, are covered. Further, the rules provide for a specific approval from RBI for any such mergers. In this context, it is important to note that RBI, in the draft regulations released for public comments recently, prescribes certain principles for a deemed approval by RBI for the merger. This is a welcome move as it should go a long way in the ease of doing business index for India, which has been a continuous work in progress for the Narendra Modi government. However, there are some open questions the draft regulations pose.
One of these is the requirement for any foreign loan in an overseas company merging into an Indian company to comply with the provisions of the ECB guidelines. Some of the requirements of RBI’s ECB guidelines are around end-usage, all in cost ceilings, maturity period, etc. For an existing loan on the books of a foreign merging company, which has been utilised in a manner not compliant with Indian ECB guidelines, ongoing compliances and reporting with the regulator may pose practical challenges. Similarly, negotiation of coupons and tenor, etc, to bring them in conformity with Indian guidelines may not always be feasible. In such a case, the Indian company may be saddled with the liability to repay such loan that can become a stress on cash flows. Perhaps striking a balance by providing a time period for ensuring compliance may be considered by RBI.
The other challenge could be in situations of outbound mergers resulting in Indian residents being issued shares in a foreign company, which again has an ownership of an Indian company, by virtue of the merger. This could happen where holding companies are merged into a foreign company. The way RBI may look at the structure from a round-tripping perspective may lead to some level of uncertainty and possible litigation.
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There are a number of other such issues that will emerge, such as the ability of an Indian company to acquire and own certain assets such as IPRs abroad, restrictions on Indian residents to own shares of foreign companies that are not joint ventures or wholly-owned subsidiaries, ability of foreign companies to own immovable property in India, etc. The current restrictions or want of clarity on some of these aspects under exchange control regulations may lead to a significantly restricted utility of these merger provisions.
The other big challenge still open for an outbound merger is tax neutrality. The current tax laws in India recognise a merger as a tax-neutral transaction for the company as well as the shareholders only when the transferee or the amalgamated company is an Indian company. Accordingly, post this liberalisation, an Indian company merging into a foreign company as well as its shareholders will need to pay capital gains tax on the transfer under the current tax framework. This could lead to complications in terms of computation of capital gains, liability to pay tax since the transferor company ceases to exist on merger, etc. Irrespective of whether tax neutrality is granted or not, a clear framework should be devised for such transactions, to provide certainty in taxation. In any case, one will need to wait till the next Budget for any such amendments to be made in the income tax law. Until then, whether outbound mergers remain more academic needs to be seen.
On balance, the well-intended measure by the ministry will need to be followed through by the other authorities involved to evolve, in what may be termed as a path-breaking reform, for corporate India from a business perspective.
Gupta is associate partner, and Acharyya is principal, Dhruva Advisors LLP. (Views are personal)